Financial Perspectives

In eras of normal economic activity there are always rumours that come true. That interest rates will fall (or rise), that the chancellor is on his way out (or not) and so on. However, it’s more of a problem in times like these.

For example, the West Bromwich building society was rumoured to be about to need a rescue package back in May. In fact, that hasn’t happened and may never happen, yet I’m quite sure that more than a few depositors with the society withdrew cash whilst other potential depositors probably decided on a different building society. So far that’s been “a few” depositors or potential depositors but it could very easily become a tide and fell the society just as happened with the Northern Rock.

And yet, we also get rumours in the other direction. Thus the markets don’t seem in such dire straits lately as they were not so long ago. The flow of companies announcing bankruptcies seems to be slowing (no substantial companies for a while now) and even the housing market may be in the first stages of an upturn.

The problem isn’t the rumours as such but rather that in dire economic times the effect of such rumours tends to be much more extreme than would normally be the case. That’s, of course, why the government tend to be somewhat more reluctant to say anything as it’s extremely easy for an off the cuff comment to be perceived as negative these days. Still, we’re sure to have a new government soon, aren’t we? Or is that just a rumour too?

The current economic difficulties are pretty unusual in their severity and therefore what “we” should do is not necessarily the same as what we’d ordinarily do by ourselves.

Typically, it’s prudent to build up some reserves in the bank to tide oneself over the hard times. However, if we all do that in the moment then chances are that the downturn will go on for a great deal longer than it needs to. What’s needed is for each of us to act as though the downturn didn’t exist as much as possible.

So, for instance, the banks have basically been told to return to normal lending practices “or else”. In fact, they need to do that for their own sake as tightening up on the lending criteria as many had been doing was simply acting to stagnate the economy which is good for nobody, including the banks.

From the rest of us what’s required is that we don’t simply bank any savings that we’re making but rather that we spend them and thereby do our bit to restart the economy.

Whilst your instinct might be to increase the size of any savings reserve as much as you are able, it’s the worst thing that we could do collectively.

That’s basically what governments around the world are doing right now when they’re supporting the banking system.

For normal people, borrowing even more to get yourself out of a hole can only be a short term solution and even then it only works if you have something else up your sleeve. Bridging loans are typically successful in this area because you’ve a house for sale on the market and will repay the loan when it’s sold.

It’s also only a short term solution for governments too, albeit the term over which they can get away with it is somewhat longer: typically several years or perhaps a decade. That “something up the sleeve” is mainly tax rises to pay interest on the loans that they’re getting and to start repaying them as well so we can all look forward to significant rises in taxes in the next term of our governments (perhaps even in the current Obama term as he won at a very unfortunate time). Other possibilities are asset sales of course so we can look forward to privatisations on a grand scale in a few years time although the unwinding of the various nationalisations of various banks will also need thought.

The other downer for governments is that borrowing more basically means printing more money which in turn reduces the value of that money which is why exchange rates are all over the place at the moment.

Of course, all this work is dependent on the banks returning to normal loan criteria and everyone spending money to get the economies going again…. not an easy thing to do when things look this bleak.